Volume In The Forex Market
Volume refers to the amount that a financial instrument has been traded over a specified period. In the Forex market, this would be how much a certain currency pair has been exchanged. For example, traders will analyze the volume of EURUSD over a 4-hour timeframe.
How is volume measured in the Forex market?
In most markets measuring volume is a relatively straightforward process since the number of contracts are simply recorded. However, currencies are not traded at a single exchange (the market decentralized) therefore it is impossible to calculate in real-time how much volume is actually being traded.
So then what is used? Forex traders use tick volume meaning the measurement is based on price movement. Let me explain…
- The smallest price move is a tick.
- When buyers and sellers execute trades it affects the price changes (tick movements).
- Tick movements are then measured over a period.
- These tick movements represent volume.
- Even though this doesn’t tell us how many orders were executed to make price move, it does provide a gauge of market activity. How you may ask? Because for price to move frequently there must be traders placing orders, thus tick movement is usually dependant and directly proportional to volume.
Finding and understanding volume on a chart
Volume data is usually shown under the price chart and displayed visually as vertical bars. Each vertical line represents the volume of the timeframe being traded e.g. on a H4 chart this shows the data for each 4-hour period.
A larger vertical line means there was greater volume traded, and a smaller line means less trading took place.
The value used to plot these lines is the number of tick changes that occurred during that time (as we spoke about earlier).
Volume on a chart
The most important considerations are – The relationship between volume and price and the fluctuations in volume at different points. Ultimately these have an influence on our technical analysis and also our risk management, which we look at next.
Role of volume in technical analysis
Traders can add confirmation to their technical analysis by analyzing the changes in volume and how they relate to price movements. Let me take you through a few examples of this relationship to gain an understanding.
1. Technical indicators
Some key indicators are calculated using volume and price data. Therefore, if a trader implements these in their analysis, then they are indirectly making a decision related to volume.
2. Market environments
Market conditions are determined by the amount of activity in the market as well as volatility. Usually, low participation equals a range, while high volume is usually associated with a trending market.
When establishing your bias, you can use the amount of activity in the market to determine the probability of a range or a trend occurring/ continuing.
Even though large moves can occur when market activity is thin, most of the time larger moves will occur when there is higher volume.
This is an important consideration when setting stop losses and profit targets as the probable distance that price will cover depends on volatility.
4. Trend continuation
If a market is rising or falling on increasing volume, you can view this as a signal of trend strength and likely continuation.
Trend traders have to consider if a move has lost its steam, so they should not enter, or if a continuation of the trend is likely, so they can trade in that direction. Looking for steady or increasing volume favours a trend trade.
When a currency pair has been trending but volume starts to fall, this is a warning that a reversal may occur soon.
If you are a reversal trader, you should look for falling volume and a struggle to make new highs (uptrend) or new lows (downtrend) to open a position.
False breakouts are a real struggle for many traders. One of the best indications of a valid breakout vs a false breakout is volume.
Breakouts from any level, line or pattern on low volume are more likely to be a false breakout. Breakouts on high volume are usually valid and will likely lead to follow through. If you are trading breakouts then this should be a significant consideration.
And there is more. Increasing volume within a range tells us Forex traders that a breakout could be coming soon. The direction etc. is unknown however you can prepare for that situation.
7. Exhaustion moves
Exhaustive moves mean that price moves a large distance within a short space of time. Usually, this leads to the market changing direction as the buyers/ sellers cannot maintain the momentum for an extended period.
Spikes such as this will often occur on outrageous volume compared to the norm, and usually, the market will be choppy or reverse after this. It would probably be best to stay on the sideline in these cases.
Role of volume in risk management
When participation in the market is high, there are a greater number of buyers or sellers to take the other side of your trade. This makes it easier to enter and exit trades which is always a safer bet.
However, the Forex market is the most liquid in the world. So as long as you are trading reasonable size, there should always be enough market participation for smooth entry and exits.
2. Trading costs
Financial instruments that are traded frequently usually have lower trading costs such as spread and commissions.
Higher volume means that spread will be tighter vs if the market is thin, reducing the overall costs for us traders. Other costs, such as slippage will be negligible in liquid conditions.
We are done and dusted. As discussed, volume is an excellent tool in gauging strength, weakness, and validity. Bring it up on your chart and see if it improves your trading approach.
Good luck on your journey.